The alternative tax computation was intended to prevent the payment of "disguised dividends," in the form of compensation, in order to avoid taxation. Despite the legislative intent behind the alternative tax, the Tribunal ruled that compensation paid to all officers (including vice president, assistant vice president, assistant secretary, and assistant treasurer), irrespective of their duties, must be added back to entire net income for purposes of computing the tax on income plus officer compensation. The decision raises concerns for corporations in New York City which give officer titles to many employees, particularly financial services, insurance, and advertising firms.

Facts

During the years at issue, Johnson & Higgins (J&H) was owned entirely by its Directors and was run by a Board of Directors. J&H's by-laws provided for two classes of officers: executive officers, elected by the board of directors; and other officers as appointed by the board of directors. The executive officers included a chairman of the board, a president, an executive vice president, a secretary, and a treasurer. Certain executive officers were also directors. The Appointed Officers, who were at issue in the case, were additional vice presidents and assistant vice presidents, assistant secretaries, assistant treasurers, and other officers approved by the board.

The executive officers, acting on the board's behalf, appointed the other officers, and set their duties and compensation. The executive officers earned approximately five times what the appointed officers did. The executive officers' earnings varied with the firm's profits, while an appointed officer's compensation was set by agreement between the firm and the individual.

The vice presidents were employees with three to five years experience, who usually functioned as insurance brokers. Many served as account executives, either for specific clients, or for seeking out new clients. The assistant vice presidents performed similar tasks, i.e., selling insurance to clients, but at a level appropriate to their more limited experience. Some individuals at both levels had administrative responsibilities instead of brokerage responsibilities. One reason for the profusion of titles was to allow these employees to be sublicensees of J&H's license to sell insurance. Further, many of the appointed officers used their title in dealing with clients and potential clients. As much as 36% of J&H's total workforce consisted of appointed officers.

The Decision

New York City argued that J&H should add back the compensation of all its officers - both executive and appointed - to its net income for purposes of determining the alternative tax base on which the income plus compensation tax is calculated. It argued that the statute requiring the inclusion of the compensation of elected or appointed officers is not ambiguous and clearly requires the inclusion of such officers without regard to their actual function or duties. It pointed out that there have been several cases decided in New York to support this contention.

J&H tried to distinguish the cases, but the Tax Tribunal found for the City. It noted that the law is silent as to whether the role actually played by officers is relevant. The Tribunal also refused to rely on Findings by New York State in earlier years that appointed officers were not required to be included in the computation for state tax purposes. The Tribunal noted that the State Tax Commission seemed to have allowed the exclusion based upon the sheer number of officers appointed by J&H and that if it followed such a precedent, it would be forced to deal with other appeals testing the status of successively smaller groups.

The Tribunal justified its decision on more than statutory or judicial economy grounds. According to the Tribunal, J&H dispensed internal status to its employees and garnered enhanced prestige in dealings with third parties by granting corporate officers titles. The Tribunal stated: "Both are business benefits. Petitioner has chosen the form in which to conduct its business and retains control over the number of officers it appoints."

The Tribunal also found that Johnson & Higgins was subject to a penalty for substantial understatement of tax because it did not disclose the fact that it was taking a position contrary to authority on its return or in an attached statement.

Planning

The Tribunal's decision in Johnson & Higgins will have repercussions for the insurance brokerage, advertising, and securities industries in New York which normally, and as business practice, confer officer titles on nonmanagerial employees. Planning for taxpayers so situated may be limited to giving nonmanagerial employees nonofficer titles and duties in order to avoid the addback. However, business practice and legal requirements in the affected industries mandate that certain classes of employees be designated as officers.

In light of the failure of the taxpayer to prevail in Johnson & Higgins, a legislative solution may be the only means of relief from the inequities of this tax.